Wednesday, September 05, 2012

The Reserve Bank is preparing to cut interest rates in the wake of a free-falling iron ore price and the first billion dollar wind-back of an existing mining investment program.

The Bank is ready to cut rates as soon as next month. It sees no need to wait for the traditional Melbourne Cup day board meeting after the release of the inflation figures in late October.

The Bank signalled its new bias toward an October 2 easing in the statement released by governor Glenn Stevens after Tuesday’s Sydney board meeting.

Whereas the previous statement, released in August, included some optimistic lines about the world economy, noting in particular that China’s growth appeared to have stopped slowing, yesterday’s assessment of international conditions was intentionally pessimistic.

Europe was contracting, growth in the United States was “only modest” and recent indicators in China had been weaker, adding “to uncertainty about near-term growth”. Asia was suffering at the hands of more moderate expansion in China and weakness in Europe.

Some financial market economists failed to pick up on the change in sentiment saying the Bank was “on hold and still comfortable” and had “sensibly resisted calls for cuts”.

In fact the Bank is deeply concerned about what it calls “sharp” falls in “some commodity prices of importance to Australia”. The iron ore spot price has slid near vertically from $US135 a tonne in July to around $US89 last night.

Tuesday iron ore miner Fortescue became the first big resources company to scale back an investment program already underway, postponing the development of the Kings deposit at its Solomon mine in the Pilbra until prices recover. It hopes to save $1.6 billion and will let go of ‘‘several hundred’’ staff.

The Reserve Bank regards the development as significant because other cutbacks, such as those announced by BHP were to projects that had not yet begun. It is especially concerned that Australia’s sliding commodity prices are not being matched by a sliding Australian dollar, meaning declining prices is not being offset by a more competitive exchange rate.

Addressing the Association of Mining and Exploration Companies convention in Perth Prime Minister Julia Gillard acknowledged “uncertainty out there” and a softening of growth in China.

“But let's be clear,” she said. “Reports of the mining boom's death have been exaggerated. This is a boom with three distinct phases: A prices boom - which is now passing, an investment boom - still to reach its peak and a production boom for the years and decades ahead.”

The Reserve Bank believes the inflation outlook gives it ample room to cut interest should resource prices stay low or keep falling as international conditions worsen. It will be paying close attention to economic statistics from China due in the next fortnight.

Bank forecasters believe that even with the 0.7 per cent prices boost expected as a result of carbon tax Australia’s inflation rate is unlikely to climb above 3 per cent for the next one to two years. It has pledged to “look through” the carbon-price effect in adjusting rates meaning that for rate-setting purposes it will treat inflation as if it is between 2 and 2.5 per cent, well within its 2 to 3 per cent target band.

June quarter national accounts to be released today are expected to show consumer spending strong and economic growth robust. They are unlikely to be much of an impediment to a rate cut because the Bank believes some of the strength was temporary, flowing from billions of dollars in bonus payments payments that stopped in July.